Federal Aid for States, Localities Protects the Economy

As federal policymakers consider another package to address the deep economic downturn, one of the most effective steps would be to provide substantial federal grants to help states address their huge revenue shortfalls, as the House-passed Heroes Act would do. That would help states and localities avoid cuts in services and investments that would worsen racial inequities — as my colleague Nick Johnson recently wrote. It would also help them avoid laying off teachers and other workers and imposing other budget cuts that would make the recession even worse and last longer.

The Heroes Act includes a temporary boost in the share of Medicaid costs that the federal government pays (known as the FMAP) — greater and likely longer-lasting than the boost under the Families First Coronavirus Response Act of March — and $500 billion in additional grants that states can use to cover their massive revenue shortfalls. That, plus earlier federal aid and state rainy day funds, could cover most of states’ shortfalls, which we’re now estimating could be about $615 billion through 2022, based on the latest economic projections from the nonpartisan Congressional Budget Office (CBO) and the Federal Reserve. The proposal also includes $375 billion in local fiscal relief, $90 billion in emergency education funding, $20 billion for tribal nations, and $20 billion for territories.

Such aid for states would protect jobs and the economy, as economists across the political spectrum have pointed out:

• Economist Glenn Hubbard, former chair of President George W. Bush’s Council of Economic Advisers, recently said, “This is a critical time to provide additional assistance to state and local governments. . . . Just as in the CARES Act, [where] we wanted to avoid excessive layoffs in the private sector, so too do we want to in the public sector. The same economic logic ports over.”
• As Christina Romer, former chair of Obama’s Council of Economic Advisers, described in detail just last year, a careful study of the 2009 Recovery Act’s state fiscal relief found that states that received more aid produced more jobs as a result, at a low cost per job compared to other forms of stimulus.
• Mark Zandi, chief economist at Moody’s Analytics, testified that every dollar that the Recovery Act provided in general aid to state governments produced $1.41 in economic activity, a strong “bang for the buck.” A recent Moody’s report estimates that if the federal government fails to provide substantially more aid to state and local governments, 4-6 million jobs could be lost.
• CBO estimated that the fiscal relief provisions in the Recovery Act delivered a bang for the buck of up to $1.80. As Doug Elmendorf, former CBO director, recently said, “[L]aying off governmental workers means more people who can't go out and buy things from small businesses. . . . And so we want to keep people at work in state and local governments . . . so that as the health conditions improve we can have people spending money to create a strong recovery.”
• The Federal Reserve Bank of San Francisco’s review of the economic literature suggests that, for every $1, the Recovery Act’s boost to local government spending produced about a $1.50 bang for the buck. For the current crisis, the Bank emphasizes, federal transfers to state and local governments will likely be spent quickly, maximizing the economic benefits that they will generate.

States’ and localities’ costs are rising rapidly as they fight the pandemic and jobless workers turn to public assistance to meet their families’ basic needs. At the same time, state revenues have fallen off the table. Sales and income tax collections — which account for most state tax revenues — are plummeting with so many businesses closed and unprecedented layoffs, and other state revenues such as gas tax collections are also way down.

Because states must balance their budgets each year, these huge revenue shortfalls mean that states must lay off workers and cut spending in other ways, raise new revenue, or some combination of the two. State and local policymakers have already laid off or furloughed a million and a half workers and are calling for other spending cuts. Without substantial fiscal aid, these furloughs and layoffs may become permanent and these cuts will come to fruition.